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Spring 2011 Midterm 2 Solutions

# Spring 2011 Midterm 2 Solutions - Solutions to Midterm II...

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Solutions to Midterm II, FIN 350, Spring 2011 Form Answer Form Answer A B A B 1 2 D 14 15 A 2 4 E 15 16 C 3 5 A 16 14 A 4 1 C 17 18 A 5 6 B 18 17 C 6 3 C 19 19 C 7 8 A 20 20 B 8 9 B 21 22 A 9 7 A 22 24 B 10 10 D 23 21 D 11 12 B 24 25 B 12 13 E 25 23 E 13 11 C 26 26 E Solutions: 1. Solution: . FCF model for valuing stock Answer: d Firm value = \$25,000,000/(0.10 – 0.07) = \$833,333,333. This is the value of the whole company, including debt, preferred stock, and common stock. From this, we subtract the \$200,000,000 in debt and preferred stock. This leaves an equity value of \$833,333,333 - \$200,000,000 = \$633,333,333. So, the price/share = 000 , 000 , 30 333 , 333 , 633 \$ = \$21.11. 2. Preferred stock concepts Answer: e MEDIUM 3. Preferred stock yield Answer: a Annual dividend = \$0.50(4) = \$2.00. r p = D p /V p = \$2.00/\$20.00 = 0.10 = 10%. 4. . CAPM Answer: c MEDIUM Risk-free rate 7.00% Old market risk premium 4.00% New market risk premium 6.00% Old required return 13.00% Beta 1.50 New required return 16.00% 5. Standard deviation, historical returns (sample SD) Answer: b HARD

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Deviation Squared from mean Deviation 2005 25.00% 10.00% 1.00% 2004 -10.00% -25.00% 6.25% 2003 30.00% 15.00% 2.25% 15.00% 9.50% Sum sqd deviations 4.75% Sum / (N-1) σ = 21.79% SQRT of above This is a relatively technical problem. It should be used only if calculations are emphasized in class or on a take-home exam where students have time to look up formulas or to use Excel or their calculator functions. 6. Beta coefficient Answer: c MEDIUM 7. Portfolio risk and return Answer: a MEDIUM 8. SML Answer: b MEDIUM 9. Market risk Answer: a MEDIUM 10. CAPM and required return Answer: d r RF = r* + IP = 3% + 5% = 8%. r s = 8% + (5%)2.0 = 18%. 11. Coefficient of variation Answer: b The expected rate of return will equal 0.25(25%) + 0.5(15%) + 0.25(5%) = 15%. The variance of the expected return is: 0.25(25% - 15%) 2 + 0.5(15% -15%) 2 + 0.25(5% - 15%) 2 = 0.0050.
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